An Economic Capital Model Integrating Credit and Interest Rate Risk in the Banking Book

36 Pages Posted: 1 Jun 2010

See all articles by Piergiorgio Alessandri

Piergiorgio Alessandri

Bank of England

Mathias Drehmann

Bank for International Settlements (BIS)

Date Written: June 1, 2010

Abstract

Banks often measure credit and interest rate risk separately and then add the two risk measures to determine their overall economic capital. This approach misses complex interactions between the two risks. We develop a framework where credit and interest rate risks are analysed jointly. We focus on a traditional banking book where all positions are held to maturity and subject to book value accounting. Our simulations show that interactions between risks matter, and that their implications depend on the structure of the balance sheet and on the repricing characteristics of assets and liabilities. The analysis suggests that a joint analysis of risks can deliver substantially different results relative to a piece-wise approach: risk integration is challenging but feasible and worthwhile.

Keywords: Economic Capital, Risk Management, Credit Risk, Interest Rate Risk, Asset And Liability Management

JEL Classification: G21, E47, C13

Suggested Citation

Alessandri, Piergiorgio and Drehmann, Mathias, An Economic Capital Model Integrating Credit and Interest Rate Risk in the Banking Book (June 1, 2010). Bank of England Working Paper No. 388, Available at SSRN: https://ssrn.com/abstract=1618864 or http://dx.doi.org/10.2139/ssrn.1618864

Piergiorgio Alessandri (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Mathias Drehmann

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

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